NOV - NOV Earnings Preview: Cash Flow Inflection Point Is Coming

2024-01-07 20:18:08 ET

Summary

• NOV Inc. has thrived in the oilfield equipment and services industry despite challenges, with solid international and offshore demand boosting earnings.
• The company's fourth-quarter results are expected to be positive, with potential improvements in the North American market and cash flow growth.
• Free cash flows could be a key theme for 2024, including its uses to fund dividends, buybacks, organic growth, or acquisitions.

Introduction

Last year presented a checkered landscape for the oilfield equipment and services industry, with the U.S. market experiencing notable weaknesses, contrasted by robustness in international and offshore sectors. Despite these challenges, NOV Inc. ( NOV ) didn't just hold its ground; it thrived, as its earnings were buoyed by solid international and offshore demand — a theme I touched upon in a previous article .

The company recently announced plans to unveil its fourth-quarter results after the market closes on Thursday, February 1. I believe NOV appears well-positioned to conclude the year on a high note. Looking ahead to 2024, the company may not only witness improvement in the North American market but also a marked enhancement in its cash flow generation, setting the stage for a promising year for shareholders.

Quick Recap

NOV Inc., which provides oilfield equipment, aftermarket parts, and services for oil and gas production, has capitalized on the rising tide of international and offshore markets, overcoming domestic challenges to bolster its earnings and profit margins.

In the first three quarters of 2023, NOV's overall revenues rose by 21% to $6.24 billion, buoyed by robust growth across its Wellbore Technologies [WT], Completion & Production Solutions [C&P], and Rig Technologies [RT] segments. This broad-based growth propelled its adjusted EBITDA up by 58% to $707 million, with all segments contributing to the earnings hike. Consequently, the company's adjusted EBITDA margin improved markedly from 8.7% in the first nine months of 2022 to 11.3% during the same period in 2023. This positive trajectory is also reflected in its GAAP net income, which rose from $0.13 to $1.00 per share.

However, cash flows have presented a more challenging picture for NOV. The company grappled with substantial cash burn in the first nine months of 2023, primarily due to heightened working capital requirements. This was a ripple effect of the pandemic's disruptive impact on supply chains, compelling NOV to hold higher inventory levels to ensure timely customer service amidst serious issues at critical equipment foundries. As a result, it reported negative cash flows from operations amounting to $324 million.

Segment analysis reveals the varying market dynamics NOV navigated. The WT segment, for example, faced headwinds from the subdued North American market, mirroring similar demand softness in the C&P segment within the same region. Nonetheless, robust performance in international and offshore markets provided a counterbalance, enabling revenue and profit growth alongside margin enhancement despite the domestic market's sluggishness.

What To Expect

The North American drilling market likely remained soft in the fourth quarter, as evidenced in Baker Hughes' ( BKR ) final weekly rig count report for 2023. Amid fluctuating WTI oil prices ranging from $70 to $80 a barrel, shale oil producers have been prioritizing shareholder returns through dividends and buybacks over ramping up production with additional rigs. This conservative approach led to a year-over-year rig count decline of 20% as reported in the last week of December 2023, marking a stark departure from the previous two years where increases were the norm.

However, the fourth quarter saw a semblance of steadiness in the US rig count, maintaining around 622 units with minor fluctuations. This relative stability, contrasting with the more pronounced declines in earlier quarters, suggests a potential leveling off of drilling activity as the year closed. While I think it may be premature to declare a definitive bottom in the North American drilling landscape, the lack of a further dip in the rig count during the fourth quarter might signal a turning point or at least a momentary pause in the downturn.

This stabilization could bode well for NOV's fourth-quarter performance. The company had previously reported a 6% sequential revenue decline in North America for Q3-2023, including a 2% drop specifically in the US onshore market. Given the fourth quarter's steadier rig count, NOV might experience an uplift in its performance, potentially leveraging this period of relative market stability in the US.

The segments of NOV's business that have been hindered by the subdued North American market might see improved outcomes in Q4, potentially outpacing performances from earlier quarters. For example, the CP segment may experience a revival in drilling and completion activities, spurring demand for its products such as eFrac.

More importantly, I believe the stability we saw in the fourth quarter could lay the groundwork for a broader improvement in the US market conditions in 2024, leading NOV to adopt a more optimistic stance on future US orders during its upcoming earnings call.

Contrastingly, the international markets have painted a much more positive picture. Due to a combination of economic and geopolitical factors, as well as sustained healthy oil prices, drilling activity has surged in key regions including Brazil, Algeria, Mexico, and Saudi Arabia, leading to an increased deployment of rigs. Baker Hughes' data indicates an approximate 9% rise in international rig count over the year through November, reflecting this global upturn. The offshore sector, in particular, has demonstrated remarkable strength, evidenced by increased demand for drillships and significantly improved day rates, as seen by operators like Diamond Offshore ( DO ).

The vitality of the international markets is buoyed by robust commodity prices coupled with rising demand for LNG. The vigor of the offshore sector is underscored by the fact that projects worth $140 billion entered the Final Investment Decision [FID] phase in 2023, marking a substantial 60% increase from the eight-year average. This shift could indicate a strategic reallocation of investments towards international and offshore projects, signaling a possible change in the dynamics of global oil market, potentially diminishing the dominant role previously played by US shale as the key source of increase in oil supplies.

NOV would have likely continued to capitalize on the strength in the international markets in the fourth quarter, which will continue to drive its revenues and income growth . All of the company’s three business segments – WT, C&P, and RT – will likely report an increase in revenues from the international and offshore markets, which could push the company’s overall earnings higher.

In my view, two aspects of NOV's fourth-quarter results will be particularly noteworthy. Firstly, the company's recent reorganization into two segments - Energy Equipment and Energy Products and Services – from the start of 2024 marks a strategic move to enhance operational efficiency and reduce costs. It’s a part of a larger initiative to save $75 million which should have yielded some savings in the fourth quarter as well, with a more significant impact anticipated for 2024. Details on these developments and expectations for future savings are likely to be a key focus of the upcoming earnings call.

Secondly, NOV's cash flow situation, which has been challenging throughout 2023, showed signs of improvement in the third quarter. Despite the lingering effects of high working capital requirements, the company reported $40 million in operational cash flows, reflecting initial positive changes in the supply chain dynamics. Although its cash flows were still in the negative for the 9M-2023 period, the improvement in Q3-2023 was certainly a step in the right direction.

Moving into the fourth quarter, further improvements are expected as supply chain disruptions ease and deliveries of raw materials and components begin gradually normalizing. I believe this potential reduction in working capital could significantly boost NOV's operational cash flows and possibly lead to the generation of free cash flows. The alignment of product shipments with a normalizing supply chain will be crucial in NOV's ability to deliver on these financial metrics.

I think generating free cash flows appears to be a feasible goal for NOV, especially since the company has demonstrated its ability to do so when adjusted for working capital changes. For example, in the third quarter, once the effects of working capital changes were excluded, NOV produced $189 million in operational cash flow. This was well above the $74 million spent on capital expenditures, yielding adjusted free cash flows of $115 million.

With the expected normalization of the supply chain, NOV is likely to begin reporting substantial free cash flows, possibly starting in Q4-2023. If the company continues to deliver excess cash in 2024, then this will provide NOV with the opportunity to enhance shareholder value through dividends and share buybacks. Additionally, bolstered cash reserves could fund further investments in growth, particularly in lucrative offshore markets, and may even facilitate strategic acquisitions.

Takeaway

In summary, NOV has demonstrated healthy revenue and income growth, coupled with margin improvement throughout the first nine months of 2023, a trend expected to persist into the fourth quarter. Signs of stabilization in the North American drilling market are likely to positively influence NOV's Q4 performance. Moreover, robust cash flows, potentially including free cash flows, are anticipated for the fourth quarter.

I believe NOV will enter 2024 on a positive note, presenting a promising outlook characterized by potential improvements in the North American market, sustained strength in international and offshore markets, and the generation of significant free cash flows, which could become a central focus for the company moving forward. With its continued revenue and income growth, alongside free cash flow generation, 2024 might see NOV not only delivering financially but also reinforcing its strategic position in the industry.

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